Exxon's Biofuel Bet

Earlier this week, the world's largest oil major announced a five-year, $600 million partnership with Synthetic Genomics Incorporated [SGI], a California-based genetic engineering firm, to develop next-gen transportation fuel-from pond scum.

This algae-based bio-oil would so closely resemble the hydrocarbons in petroleum that it could be processed by refineries, be transported through pipelines and fill up car and airplane gas tanks without any upgrades or replacements needed. Sounds pretty fanciful, eh?

The partnership is an unexpected change of course for Exxon, who, for the past several years, has scoffed both at biofuels and alternative energy in general. After all, it was only two years ago that CEO Rex Tillerson famously accused ethanol of being "moonshine."

So will this new venture-one of the largest Big Oil/Bio Oil team-ups ever-signal a coming of age for the beleaguered biofuel industry? Or will it be subsidized ethanol all over again?

Why Algae?

Even as Tillerson was publicly turning his nose up at biofuels, Exxon (NYSE: XOM) was secretly weighing its options, assessing the scientific challenges and commercial viability of the various technologies on the market.

"It's fair to say that we looked at all the biofuels options," said Dr. Emil Jacobs, VP of R&D at ExxonMobil's Research and Engineering Lab in an interview with the New York Times. "Algae ended up on top."

Currently, most biofuels derive from agricultural crops: Ethanol, for example, is processed from sugarcane or corn, and biodiesel is distilled from plant oils, most commonly soybeans. But hydrocarbons can come from other sources too, like algae, that produce them directly and store them within their bodies as food for hard times. A kind of biological gold-bug mattress-stuffing.

Algae also offer several advantages that agricultural crops can't: They reproduce on their own, they can live in nonarable land and they don't need fresh - or even clean - water to survive. In addition, these single-celled organisms require much less space to grow: Current strains of algae can produce 2,000 gallons of fuel per acre, compared with 250 gallons for corn-based ethanol.

But best of all, the molecular structure of algae oil naturally resembles that of petroleum - not too surprising, considering much of today's crude oil was made by oceanic algae 500 million years ago.

According to the energy research group Carbon Trust, by 2030, algae fuel could sub in for more than 70 billion liters of fossil fuels used each year. That's about 12% of the total jet fuel yearly, or 6% of all auto diesel - an annual saving of over 160 million tons of greenhouse gases.

Until recently, however, the cost and technical challenges behind mass-produced algae oil have been prohibitively large, although as technology advances, the price tag has come down quite a bit. Still, according to the FT, the estimated cost of producing algae-based biofuel stands at $33/gallon - compared with $2/gallon to produce Saudi crude.

Carbon-Chomping Pond Scum

That's where Exxon comes in. Under the partnership, the company is funding a new SGI research lab in San Diego, where the genomics firm can research ways to enhance algae for mass production.

Genetic engineering is key, says J. Craig Venter, co-founder of SGI, and best known as the leader of the team who decoded the human genome. "It's the only way we can change the yield far beyond nature, and make the algae resistant to virus attacks, and so on," he told FT.

Because algae are single-celled organisms, their genetic structures are simpler than those of other biofuel crops (like corn), and are therefore easier to manipulate. That means SGI can custom-build new strains of algae that will secrete refinery-ready oil-and even consume excess carbon dioxide.

These carbon-chomping algae farms could therefore be situated close to existing power plants, using the emissions generated there to feed the hungry pond scum. Exxon could find this carbon recapture system quite handy, should the Waxman-Markey energy bill pass the Senate. Under the bill, Congress would institute a carbon cap-and-trade program, allowing companies to sell credits for any emissions savings they generate on the open market.

Of course, how much carbon could be recaptured in such a project is debatable. Point Carbon senior analyst Greg Singleton told the WSJ that although algae could conceivably reuse up to 40% of a coal-fired power plant's carbon emissions, it would also take a farm about 13.1 square miles across. "On paper it looks attractive," he said, "[but] I haven't seen it done on a large scale."

Big Oil Teams With Bio-Oil

SGI is no newbie to Big Oil partnerships, as the firm has already signed up with BP (NYSE: BP) to develop coal-eating algae. And several other Big Oil/Bio Oil joint ventures are in the works.

In June, Algenol Biofuels partnered with Dow Chemical (NYSE: DOW) to construct a $50 million test algae fuel farm. And the firm also signed an $850 million licensing agreement with Sonora Fields to develop a Mexican algae farm that, when viable, could produce up to a billion gallons of fuel annually.

But it hasn't been all green shoots for algae oil. Take GreenFuel Technologies, who, after scoring several major investors and a $92 million algae farm in Spain, ended up shuttering its doors earlier this year.

The difference now, says Venter, is Big Oil's involvement. "This would not happen without the oil industry stepping up and taking part," he told The Guardian.

From Exxon's perspective, it has little to lose. Over the years, the oil giant has felt increasing pressure from its shareholders to explore alternative energy sources, and politicians have not only passed new alt-energy tax breaks and incentives, but are mulling new tax hikes for oil refiners and drillers.

Besides, $600 million is a drop in the bucket for the world's largest publicly traded oil company. It barely registers next to the $29 billion Exxon will shell out this year to find new sources of crude oil and natural gas, and the amount seems even less when compared with Exxon's record $45 billion profit in 2008.

Although Exxon is prepared to drop billions more if SGI finds a way to generate low-cost, commercially viable algae oil, pond scum pumps at the corner gas station are still several years away.

"We need to be realistic," said Dr. Jacobs on a conference call. "This is not going to be easy, and there are no guarantees of success."

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